The case against the 'gig economy'

When I first met Andrew Berlin at a Stanford executive program in the early 1990s, Berlin Packaging was a small enterprise doing maybe $40 million in sales in what was then, and still is, a very tough, almost commodity-like industry. Today, the packaging company brings in close to $1 billion in annual revenues, Andrew Berlin has an ownership interest in the Chicago Cubs and a World Series ring from his past ownership interest in the White Sox, and he runs a company growing earnings at a low double-digit rate that achieves good margins.

Andrew Berlin has made a fortune by building a competitive advantage through his company’s culture and his people. Having recently joined Berlin’s board, I could anticipate Andrew’s answer to my question, “why have employees?” First of all, he said with a chuckle, “I like my employees.”

More fundamentally, Berlin said that his company is special because he has employees who are interested in both beating the competition and delighting others. “Contractors would not have the same level of commitment,” he added. If organizational culture is a key to competitive success, you can’t just turn that over to someone else.

Ed Ossie, COO of insurance software company Majesco, also believes in the importance of culture and people for business success. When I asked him that same question—why have employees in a business where outsourcing and contracting is common—his reply focused on the connections between people and profits. “Talented, trained employees treated well by their employers will treat customers well and deliver exceptional service,” Ossie said. “Customers will remember our employees delivering exceptional service and will find reasons to extend the commercial relationship with our company.”

Such perspectives are exceedingly rare as the U.S. and other countries confront what has been called the “gig economy,” and as notions of what it means to have a job change in profound ways.

Freelance Nation: Population unclear

Nothing about the new employment arrangements lacks controversy, including how significant such contingent work is. A recently published piece in TheWall Street Journal noted that official U.S. government data show no dramatic changes in either the percentage of Americans who say they are self-employed (only about 6.5%) or who say they are working multiple jobs.

A response to the WSJ piece noted that estimates of the proportion of people in several major cities who received 1099 (miscellaneous income) forms ranged from 10% to 20%, and that the proportion of people filing Schedule C (self-employment income) forms with their income tax returns had increased in the recent past. These trends were taken to imply a rise in self-employment or at least an increase in the percentage of people receiving self-employment income. A 2015 survey of over 1,000 American workers noted that about 60% received 25% or more of their income from freelance work. That same report maintained that about 34% of workers had freelance jobs. And financial software company Intuit estimates that this proportion will grow to some 40% by 2020.

The U.S. Government Accountability Office (GAO) attempted a study in 2000 of contingent work arrangements in response to a request from Congress. Among its conclusions: the percentage of the U.S. workforce that could be characterized as contingent or on-demand ranged from 5% to 30%, depending on the precise definitions used. No wonder there is so much disagreement and confusion!

The Gallup organization has studied what it calls the payroll to population ratio (P2P), the percentage of the adult population that reported being employed full-time. For 2014, Gallup reported that this ratio had remained unchanged worldwide at about 26%. And lest anyone think that freelancing is a sign of a robust economy, Gallup’s report noted that “the countries with the highest P2P rates tend to be some of the wealthiest,” while countries with lots of self-employment and few people working full time included places like Mali, Niger, Liberia, South Sudan, and Sierra Leone.

What is not in dispute is that the proportion of contractors, freelancers, and part-time, contingent workers in the U.S. has been increasing and has been for a long time. More than 25 years ago, James Baron and I published a paper on the trend to “take workers out” of their companies, documenting the trend—and its causes—of companies using more part-time people, temporary help, and outside contractors in place of full-time, regular employees.

Speaking of companies, they seem to be going the way of full-time jobs—disappearing. Gerald Davis, a business school professor at the University of Michigan who is writing a book about the disappearance of the corporation and its implications for society, told me that since 1997, the number of public corporations in the U.S. has fallen by more than half and that the “going public” fad of the 1990s is long gone. There were about one-third the number of IPOs in 2014 as there were in 1999. And it’s not just publicly traded corporations. As economist Richard Florida wrote in 2014, the rate of new business formation has declined by almost 50% since 1978.

Moreover, Davis argued that the new companies being formed may make tons of money for their founders and early stage investors, but they produce precious few real jobs. According to Davis, as of December 2014, Uber, which had a reported enterprise value of $50 billion, had about 2,000 employees but more than 160,000 “driver-partners” in the U.S. alone, while Netflix employs a small fraction of the number of employees that used to work in the company it supplanted, Blockbuster.

What “gig workers” stand to lose

In the U.S., for good or bad, many benefits and social assistance programs are largely, though not exclusively, handled by employers. The U.S. is unique among advanced industrialized countries in not offering universal health care coverage. Instead, coverage decisions are at employers’ discretion. According to the Kaiser Family Foundation, even though employer-provided health insurance coverage has declined, about 58% of the nonelderly population still received employer-sponsored health insurance coverage in 2013.

A similar situation holds for pensions. Even though employers have moved aggressively from offering defined-benefit to defined contribution plans since 1998, most large employers still offer some form of retirement plan. Employers make contributions to Social Security for their employees, and while the self-employed are required to contribute, their contribution rate is less than that of the combined employee-employer rate.

Unemployment insurance, an important countercyclical source of income, is funded through levies on employers based on their number of employees and the stability of employment. Employers that have resorted to significant layoffs and firings often face higher contribution rates. Similarly, workers’ compensation benefits for on-the-job injuries rely mostly on experience-based employer insurance contributions. And many employers provide disability coverage, which can be an important supplement to disability payments provided through Social Security.

In addition, employers, particularly large employers, often offer various forms of assistance, including wellness programs to help employee manage their weight and stress, smoking cessation programs, and other forms of assistance for mental health, alcoholism, and addiction issues.

What happens to these benefits when fewer people hold traditional working relationships with employers? Individuals will have to shoulder significant risk, and taxpayers will likely end up paying for these services. Inadequately paid employees already benefit from public assistance—which has led to a conservative case for raising the minimum wage so the state doesn’t wind up subsidizing low-wage employers. People who can’t afford to retire or lack needed benefits are more likely to wind up on some form of public assistance.

The GAO report on the contingent workforce presents a series of dire, but not surprising, findings, including, “contingent workers are also less likely … to receive health insurance and pension benefits” and that such workers are generally not covered by wage and hour regulations, which include overtime pay and limits on hours worked, designed to protect workers.

Although contingent work is often promoted for the flexibility it offers, a study of reasonably well-paid technical contractors in Silicon Valley found that such latitude was a mirage. Because contractors need to maintain their reputations in the market, because they often bill by the hour and are chronically aware of what downtime costs them, and because of the nature of the work itself, “markets place more rather than fewer constraints on workers’ time.”

Moreover, much research shows that economic insecurity has adverse health effects. One study, using data from the Panel Study of Income Dynamics, found that the negative health effects associated with job loss persisted even after workers found new jobs.

The heart of the matter

Worker well being is often ignored in discussions that emphasize productivity, profitability, economic growth, and similar concerns. In response, Pope Francis “has defined the economic challenge of this era as the failure of global capitalism to create fairness, equity and dignified livelihoods for the poor.”

Of course, taking care of human beings and turning a profit are not mutually exclusive goals. Robert Chapman has run privately owned manufacturing firm Barry-Wehmiller for years, enjoying a compounded annual return in profits of 16% annually. Chapman believes that “leadership is the stewardship of the lives entrusted to us,” and those lives include his employees. According to Chapman, having employees offers “a chance to profoundly affect the lives and wellbeing of others.”

As the cases I have discussed make clear, business success comes from having something that others cannot readily imitate. What a company can buy on the open market, others can too. That is why successful executives ranging from Bain consultant Fred Reichheld to Men’s Wearhouse founder and former CEO George Zimmer have long emphasized the powerful relationship between cultivating talented, loyal employees and having dedicated, long-term customers.

The so-called “sharing economy” has been better at disbursing pain and economic stress than in providing people with good jobs and stable incomes. People are better off as employees, covered by employment protections, offered benefits, and, most importantly, having both greater income security and the benefit of being affiliated with an organization and fellow employees who can provide social support. Society is better off not having to shoulder the burdens offloaded by businesses that do not provide steady incomes or benefits to the people who do their work. And companies can benefit from having committed employees who can provide the customer service and innovation that leads to success.

Beyond the issue of costs and benefits, there is the matter of human dignity and well being. This is the concern that animates the current Pope and many of his predecessors. It is something that should concern everyone, regardless of their religion. All faiths value human life. So should we all.

Jeffrey Pfeffer is the Thomas D. Dee II Professor of Organizational Behavior at the Graduate School of Business, Stanford University. His latest book, Leadership B.S.: Fixing Workplaces and Careers One Truth at a Time will be published in September 2015 by HarperCollins.

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